Financial Condition Reporting

FINANCIAL CONDITION REPORTING Ioana Abrahams 13 November 2009 AGENDA  Current methodology  Background Financial Services Board  FCR  FCR to date  FCR Graphical Overview  Model options under FCR  Prescribed Model  Internal Model  Partial Model 13/11/2009 Slide  Conclusion  Way forward CURRENT METHODOLOGY  Current methodology  Insurance liabilities: Financial Services Board  Outstanding claims reserves (OCR)  Incurred but not reported reserve (IBNR)  Unearned premium provision (UPP)  Unexpired risk reserve (URR)  Contingency reserve: 10% of NWP  Capital requirement:  Additional amount: 15% of net written premium (NWP)  Minimum of R3 million (shortly to be increased to R5 million then 10 million under FCR) 13/11/2009 Slide BACKGROUND  Current methodology doesn’t allow for:  Underlying risks Financial Services Board  Size of insurer  Diversification / concentration  Risk management  FSB is implementing risk-based supervision  IAIS requirements must be met  Act changes made during 2008 to facilitate FCR  World-wide trend to move to different techniques 13/11/2009 Slide FCR TO DATE  The FCR process was started in 2002  Various working groups formed Financial Services Board  The first calibration done during 2005  First issues paper released for comment in December 2006  Comments received were taken into account and this resulted in a recalibration exercise  Recalibration exercise started in 2007; now nearly complete 13/11/2009 Slide FCR GRAPHICAL OVERVIEW Free Assets Financial Services Board Excess Assets Minimum Capital Requirement Minimum of R10m Fair value of admissible assets Risk management Fair value of assets Liabilities Consist of best estimate plus additional prescribed margins VERY SIMILAR TO LIFE INSURANCE 13/11/2009 Slide Financial Condition Report MODEL OPTIONS UNDER FCR  Prescribed Method  Industry structure Financial Services Board  Industry Parameters  Internal Models  Company structure  Company parameters  Peer review (application)  Annual certification by an actuary  Partial Models 13/11/2009 Slide  A combination of above two options  Revised issues paper PRESCRIBED MODEL  Based on aggregate industry data – “average” view  Formulae for reserves and margins Financial Services Board  Capital requirement allows for proportional reinsurance and expenses  Some shortcomings of initial model:  Non-proportional reinsurance  Data not always reliable  Cell business  Reinsurance companies 13/11/2009 Slide PRESCRIBED MODEL  Capital requirement  Consists of: Financial Services Board  Asset Capital Charge • Very small part of total capital charge • Protection against loss in market value of the assets backing the liabilities and other capital elements  Insurance Capital Charge • Major part of total capital charge • Calculation tool in ST return 13/11/2009 Slide PRESCRIBED MODEL  Assets  Use current Act & Directives Financial Services Board  Insurance liabilities  Claim liabilities  OCR – best estimate (should be the same)  IBNR – six-year run-off per business class  Premium liabilities  UPP – as before, seen as 75% sufficient  URR – as before  Prescribed margins take liabilities to 75% sufficiency 13/11/2009 Slide 10 PRESCRIBED MODEL: REVISED  Small working group was formed in 2007 Financial Services Board  Considered comments on how previous method could be improved  Terms of reference for recalibration  Deloitte was appointed for the recalibration exercise  Three years of data added (FY 2005 - 2007)  Aims:  Simplify previous method  More appropriate method for typical insurers 13/11/2009 Slide 11 PRESCRIBED MODEL: REVISED  The following changes were made to the previous prescribed model: Financial Services Board  Simplify diversification and correlation  Discounted IBNR  Credit Risk: Reinsurance  Credit Risk: Assets  Non-proportional reinsurance (MER)  Remove expense and investment return adjustment  Minimum CAR – will include an allowance for operating expenses and operational risk 13/11/2009 Slide 12 PRELIMINARY RECALIBRATION RESULTS Financial Services Board 13/11/2009 Slide 13 EFFECT OF UPDATES Financial Services Board 13/11/2009 Slide 14 INTERNAL MODEL  This is (in our opinion) what an insurer should develop – However: Financial Services Board  Determining regulatory capital should not be the primary reason  Appropriateness with respect to complexity of risks  Detailed data required  Guidance will be updated, taking international practices into account 13/11/2009 Slide 15 INTERNAL MODELS  Qualitative standards Financial Services Board  IM based on sound risk management principles and structure  Integral part of day-to-day management  Independent review  Audit trail  Analysis of change 13/11/2009 Slide 16 INTERNAL MODEL  Specification of risk factors  Must consider all risks Financial Services Board  Rank most important risks  Suitable method chosen – not necessarily stochastic  Allow for correlations between risks (method not prescribed)  Stress testing  Specific tests not prescribed  Test model sensitivity to assumptions 13/11/2009 Slide 17 INTERNAL MODEL  Sign-off and review  Board assumes ultimate responsibility Financial Services Board  Statutory actuary sign-off of calculations  Actuary to follow professional guidance  IAA guidance on internal models  SA guidance for reserving completed  External review required for approval (at this stage) 13/11/2009 Slide 18 INTERNAL MODEL  Proposed model approval process  Approval for calculating regulatory capital Financial Services Board  External providers’ models not approved automatically  Application form  On-site visits  Use test, calibration test, statistical quality test  Model used at least one year prior to implementation  Progress from prescribed  partial  internal model  Can’t regress without approval  Application subject to a fee 13/11/2009 Slide 19 PARTIAL MODEL  This is a combination of own company specific factors and industry factors Financial Services Board 13/11/2009 Slide 20  Same approval process proposed as for the full internal model route CONCLUSION  The FCR model is specific to the short-term environment Financial Services Board  The proposed FCR approach fits in with international developments  Risk-based capital requirements  A better model to run an insurance business 13/11/2009 Slide 21 WAY FORWARD  New Solvency Assessment and Management (SAM) project Financial Services Board  Based on Solvency II  Will encompass both life and short-term insurance  Work done to date on FCR will be the first draft for discussion for short-term insurance  First Steering Committee meeting end November 2009 13/11/2009 Slide 22  Full implementation January 2014; however, standardised model for short-term insurance to be implemented on January 2012 THANK YOU Ioana Abrahams Actuarial Analyst: Insurance Tel: 012 428 804 Email: ioanaa@fsb.co.za